Advantages & Disadvantages of Cost Benefit Analysis

Cost benefit analysis, also referred to as “benefit cost analysis,” is a method of evaluation that estimates the value of projects to determine whether those projects are worth undertaking or continuing. At its most basic, cost benefit analysis, CBA, could be a calculation that continuing production of a product or product option is no longer viable. At its most complex, CBA can be used to take into account the benefits the company receives as well as the benefits that accrue to the community at large.

Simplicity

The main advantage of cost benefit analysis is that it is easy to understand. You are simply looking at whether benefits outweigh costs. When you do this quantitatively, measuring the dollar amount of the benefits and the costs involved in a project, the cost benefit is very easy to see. This clarity means that everyone involved will understand the monetary nature of the project and the question of its continuance. Its simplicity also means that doing a CBA is easily possible for various scenarios, locations and more.

Estimation

The simplicity of cost benefit analysis can paradoxically lead to complications. For instance, if you are performing a cost benefit analysis to determine whether or not to take on a project, you have to be able to perform accurate estimations about the benefits you would receive from the project. If your calculations are inaccurate, you could deem a project viable, only to later discover it ended up costing the company money. Likewise, you may decide to halt such a project, only to later find that consumer attitudes have changed and you missed out on being a trailblazer in that product type. The best estimations may not line up with actual consumer behavior.

Unit of Measurement

Moreover, to gain this simplicity, you have to use a common measurement — one of the disadvantages of CBA. Determining the quantitative benefits of a project is relatively straightforward; you basically add up the costs and the profits and compare the two. However, when you factor in qualitative benefits, the picture can become more complicated. For example, if you are considering implementing an employee bonus program, you will obviously incur costs. In exchange, you may receive benefits like increased employee satisfaction, decreased turnover and greater productivity. The benefits are significant but difficult to compare — apples to apples — to the costs involved.

Accuracy

Further, accuracy with regard to benefits and costs must be closely monitored because benefits are easy to double count. For example, if you are using CBA to decide whether to build a highway, you may be tempted to tally the increase in property values along with reduced travel time. However, property values would include, to a large extent, the value of location with regard to travel time; thus, if you count both, you would overestimate the project’s benefits.

About the Author

Renee O'Farrell is a freelance writer providing valuable tips and advice for people looking for ways to save money, as well as information on how to create, re-purpose and reinvent everyday items. Her articles offer money-saving tips and valuable insight on typically confusing topics. O'Farrell is a member of the National Press Club and holds advanced degrees in business, financial management, psychology and sociology.

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